Savings, investment, funding markets are key to recovery

Release date
14 July 2009

Household savings, investment in the tradable sector, and deeper funding markets are the key to New Zealand's economic recovery, Reserve Bank Governor Alan Bollard told a Hawke's Bay business audience today.

"Early signs of global recovery have now emerged. We have avoided a repeat of the Great Depression," he said. However, world growth will probably be subdued for the next one or two years, and the current low international interest rates, expansion of liquidity and central bank balance sheets, and fiscal stimuli will be necessary for some time.

"New Zealand looks likely to start recovering ahead of the pack. But this is an opportunity to rebalance. Getting the sort of sustainable recovery we want will be assisted by: first, greater savings by the household sector, to reduce the need for foreign funding of the economy; second, investment in the economy's productive base, particularly in the tradable sector; and third, greater durability and depth in funding markets, including a lengthened maturity structure for bank funding.

"A clear risk over the medium term is that households resume their ‘borrow and spend' habits before they have paid down some of their existing debt. This could be triggered by renewed moderate house price inflation, and needs to be avoided."

With slower growth in household income expected, households would have to reduce spending growth to repay their debt. "Reliance on past experience of strong house price inflation and easy credit will be untenable."

Increased household saving would have the added advantage of providing a more stable source of funds for business investment and expansion, reducing reliance on foreign funding. This would contribute to more stable and lower interest rates, thus promoting a more sustainable growth path.

Stronger world demand and a weaker New Zealand dollar would provide the signal that investment needs to move to the tradable sector to help correct the current account gap. However, financial markets were currently focused on a US dollar correction. "We hope that, in the next phase of recovery in financial market sentiment and return of risk-seeking, the markets will be more discriminating about New Zealand," Dr Bollard said.

A priority over the coming year or so would be for New Zealand banks to diversify their funding sources more, and to increase the proportion of stable funding sources, including long-term wholesale borrowing and retail deposits. The Reserve Bank's recently released prudential liquidity policy for banks will reinforce this move.

The Reserve Bank appreciated that interest rates are a blunt instrument to curb excessive borrowing, Dr Bollard said. "We see prudential policy potentially playing a greater role in the future."

Attention is now focused internationally on the potential role of minimum capital and other prudential requirements on banks in dampening business cycles, the impact of smaller and peripheral financial institutions on financial system behaviour, and how cross-border financial activity should be monitored or regulated.

In the recovery, he said the Bank's focus will be on keeping inflation expectations anchored, the macro-economy stable, system liquidity available and the financial system stable, so that funds keep flowing and relative price signals work.

The Reserve Bank would be closely watching the international debate in these areas for insights into improving its own framework. "At this point we are reasonably well-positioned to adapt in light of the new thinking, with a conservative approach to bank capital adequacy, the new legislation bringing the regulation of non-bank deposit takers into our responsibilities, and long experience in managing macroeconomic stability, financial stability and prudential policy functions under one roof.

"The New Zealand economy has taken knocks in this crisis, but some form of recovery is now on the horizon. Our opportunity is to use this time to rebalance the economy for the medium term."

Media contact:
Mike Hannah, Head of Communications,
Ph 04 4713671, 021 497418, mike.hannah@rbnz.govt.nz